Financial Development and Income Inequality: A U-shaped Relationship

Sheraz Mustafa Rajput (sheraz.mustafa@ksbl.edu.pk), Muhammad Nadeem Javaid and Ahmad Junaid
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Sheraz Mustafa Rajput: Department of Business Administration, Karachi School of Business and Leadership, Pakistan
Muhammad Nadeem Javaid: Department of Business Administration, Karachi School of Business and Leadership, Pakistan
Ahmad Junaid: Department of Business Administration, Karachi School of Business and Leadership, Pakistan

Asian Journal of Applied Economics/ Applied Economics Journal, 2023, vol. 30, issue 2, 38-53

Abstract: This paper investigates how changes in financial development may affect income inequality. We apply the ordinary least squares method, controlling for time and country fixed effects, to an international panel dataset consisting of 195 countries and covering the period from 1990 to 2021. The findings reveal a U-shaped relationship between financial development and income inequality. The development of financial institutions initially lowers income inequality. However, any further advancement, once societies attain a certain threshold of fair distribution, leads to a worsening of income distribution. This is an interesting result as previous literature discusses positive, negative, or inverted U-shaped relationships between financial development and income inequality. For a decomposed sample of strong versus weak democracies and high- versus low-income countries, the finding of a U-shaped relationship firmly holds for strongly democratic and high-income countries.

Keywords: financial development; income inequality; democracy level; income level; international panel data (search for similar items in EconPapers)
JEL-codes: O15 O16 (search for similar items in EconPapers)
Date: 2023
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